Convertible financial instruments, such as convertible bonds or convertible preferred stock, are financial instruments that may be converted or exchanged for another financial instrument, such as a different financial instrument issued by the issuer of the convertible financial instrument or a financial instrument issued by a third entity. Convertible financial instruments can be of various types which provide differing benefits to an issuer.
For example, a zero coupon convertible is a convertible bond that pays no cash interest, but is issued at a deep discount from its face value and pays its face value at maturity. Some benefits of a zero coupon convertible to an issuer include cash savings due to the lack of interest payments and the ability to take tax deductions based on the original issue discount (e.g., the price at maturity minus the issue price).
Another example of a convertible financial instrument is a cash pay convertible bond, which is a convertible bond that pays cash interest over the life of the bond. Compared to a zero coupon convertible, a cash pay convertible has a shorter duration and is therefore less vulnerable to interest rate risk. As such, a cash pay convertible may provide to an issuer the benefit of greater marketability to certain purchasers, as compared with a zero coupon convertible.